The Slope and the Curvature of the Yield Curve in Recession Forecasting

In this paper, we investigate the ability of two popular models to forecast the deviation of GDP from its long-run trend, i.e. inflationary and output gaps. In doing so, we exploit the information provided by the yield curve that is documented in the literature as a good predictor of economic activity. We combine and train our forecasting model using interest rates from Treasury Bills and Government Bond rates for the period 1976Q3 to 2011Q4, in conjunction with the quarterly real seasonally adjusted GDP for the same period. Our results show that we can achieve an overall forecasting accuracy of 80% on out-of-sample data. However, our main focus in this paper is to construct a forecasting model for the recessions. Perfect accuracy in recession forecasting is achieved in more than one of the created models. The forecasting performance of our model strengthens the conviction that the yield curve can be a useful and accurate predictive tool